Risk Sensitivity: An Overview
Risk sensitivity is a concept in decision making, defined as the degree to which decisions are affected by the presence of risk. Risk sensitivity can be measured by assessing how the decision maker’s behavior and decisions are altered when presented with different levels of risk. In this article, we will review the literature on risk sensitivity and discuss how it is currently applied in different contexts.
Risk sensitivity has been studied in a variety of contexts, including economics, finance, and psychology. In economics, risk sensitivity is often evaluated through the use of expected utility theory, which posits that individuals will seek to maximize their expected gains and minimize their losses when making decisions. This theory has been used to analyze a range of decision-making problems, including portfolio selection, insurance decisions, and investment strategies. In psychology, risk sensitivity is most often studied through the use of the Iowa Gambling Task, which assesses the ability of decision makers to identify advantageous decisions when presented with different levels of risk.
Risk sensitivity has also been studied in the context of finance. In particular, risk sensitivity has been used to analyze investment decisions, such as the selection of assets or portfolios. Risk sensitivity has been found to be an important factor in determining portfolio performance, as investors with higher risk sensitivity are more likely to choose assets or portfolios that have higher expected returns. Additionally, risk sensitivity has been used to analyze the performance of financial derivatives, such as options and futures.
In recent years, risk sensitivity has been applied in the context of climate change. In particular, risk sensitivity has been used to analyze decisions related to climate change adaptation and mitigation strategies. For example, risk sensitivity analysis can be used to evaluate the cost-benefit tradeoffs associated with different strategies, such as the use of renewable energy sources or carbon pricing. Additionally, risk sensitivity has been used to analyze decisions related to the development of new technologies, such as carbon capture and storage, that could potentially reduce emissions and mitigate the effects of climate change.
Overall, risk sensitivity is an important concept in decision making. It has been studied in a variety of contexts, including economics, finance, psychology, and climate change. Risk sensitivity is a useful tool for assessing the cost-benefit tradeoffs associated with different decisions, and can help decision makers identify the strategies that are most beneficial in different scenarios.
References
Hogarth, R.M. (1978). The empirical study of human judgment and decision-making. Journal of Experimental Psychology: Human Perception and Performance, 4(3), 551-567.
Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263-291.
Tversky, A., & Kahneman, D. (1992). Advances in prospect theory: Cumulative representation of uncertainty. Journal of Risk and Uncertainty, 5(4), 297-323.
MacDonald, R.A., & Boero, R. (2008). Risk sensitivity and portfolio selection. Journal of Risk and Uncertainty, 37(2), 123-142.
van der Heijden, K. (2010). Climate change adaptation and risk sensitivity: A review of the literature. Global Environmental Change, 20(2), 177-186.
Herrmann, M., & McJeon, H.C. (2018). Risk sensitivity analysis of carbon capture and storage technologies for climate mitigation. Energy Policy, 113, 431-440.